During the great financial crisis (GFC), the cap rate spread fell to nearly zero amid rapidly deteriorating financial market conditions. Spreads rose above their long-term average in 2009 and were generally above 300 bps in the early post-GFC recovery, except for two events: the 2011 debt ceiling fight in Congress and the 2013 Taper Tantrum. In the fall of 2021, these events are eerily similar.
Another debt ceiling battle is underway in Congress, with a deadline to act by Dec. 3, 2021, to avoid a government default. Plus, concerns have been rising about how markets will react to the Fed tapering of their pandemic liquidity measures. The good news is that the markets were sanguine after the Federal Open Market Committee’s (FOMC) September meeting.
After the 2013 Taper Tantrum, the cap rate spread to UST hovered near its long-term average, reflecting healthier fundamentals and capital market conditions for real estate. The economic recovery reduced vacancies and boosted rents, commercial lending improved, and capital flowed back into the asset class.
In fact, so much capital flowed to real estate that upward movement in the UST from 2016 to 2019 compressed the cap rate spread instead of pushing cap rates higher. A period of rising interest rates does not necessarily mean cap rates will rise. If real estate remains in favor due to growth expectations and/or a better relative risk profile, spreads can compress instead. Typically, cap rates will trend upward as interest rates rise, but not at the same pace, as illustrated in Figure 1.
Cap rates by property type
Thus far, the cap rate discussion has centered on one cap rate for all property types combined. Cap rates by property tend to trend together over the long term but can have wider variations amid secular trends, such as the growth of e-commerce and increased use of home offices.
NCREIF provides current value cap rates for the four main property types: apartment, industrial, office, and retail. As of the second quarter 2021, current value cap rates averaged 3.53% for apartments, 3.89% for industrial, 4.40% for office, and 4.49% for retail.